WHAT IF WE DO GO OFF THE CLIFF?

Will the economic stress be as severe as many assume?

What are the chances of a fiscal cliff deal? Every day seems to bring a new assessment from the media. If a deal isn't reached, what might result for the economy and the markets?1

What's the worst that could happen? For that scenario, we might as well check in with "Dr. Doom." That is the nickname for Nouriel Roubini, the economist who famously predicted the 2008 Wall Street downturn. Earlier this month, Roubini told Bloomberg TV that "there's a highly likely chance we're going to go over the cliff." Come January, "the market reaction is going to force the two sides to reach an agreement." Roubini thinks that even with an agreement, our 2013 GDP will be about 1.7%. On a positive note, he feels that "the [long-term] fundamentals of the U.S. are a lot stronger" than those of other key world economies.2

Roubini's forecast is far from the worst out there. In its gloomiest scenario, UBS sees a 2% contraction in GDP for the first half of 2013 with the S&P 500 trading at 1,000-1,100, demand for the dollar soaring, and prices of metals and energy futures sinking. Morgan Stanley thinks there could be as much as a 5% hit to GDP given that the payroll tax holiday will also likely expire; Bank of America sees anywhere from a 2.5%-4.6% impact on 2013 GDP, with a multi-stage fix for the problem on Capitol Hill wrapping up by April. The Congressional Budget Office's worst-case scenario includes a recession and 9.1% unemployment.3

Could we merely see a fiscal slope, or a fiscal pothole? If a deal is deferred until late January, the economic impact might not be as bad as feared. Congress could end up retroactively preserving the Bush-era tax cuts for most Americans, and the tax increases resulting from the cliff could be struck down.

Here's why it looks like a slope rather than a cliff: the so-called sequester (the $1.2 trillion in planned federal spending cuts) will occur gradually over the next decade rather than instantaneously. If no deal occurs, next year's across-the-board federal spending cuts will total only $109 billion, and they could even be smaller if Congress hastily opts for a package of selective cuts rather than a real fix; one proposal circulating around Capitol Hill this fall only called for slashing $55 billion in 2013, according to Reuters.4

In the fiscal pothole scenario offered by analysts at UBS, small concessions are made on Capitol Hill as 2012 ends (i.e., the payroll tax holiday and long-term jobless benefits expire while taxes increase temporarily), pursuant to a "grand bargain" in 2013 that cuts at least $4 trillion off the deficit in ten years.3

What sector would be hit hardest if there is no deal? As an article at TheStreet.com mentions, the consumer discretionary sector may be significantly impacted without a fiscal cliff fix for 2013. The automotive, apparel and entertainment industries in particular might see waning consumer demand.5

If the economy does fall off the cliff, the effect will probably be felt gradually by businesses large and small. The sudden shock may occur on Wall Street, which in the glass-half-full scenario prices the fall in without bulls fully retreating.

Citations.
1 - news.yahoo.com/reid-u-senate-return-dec-27-no-pre-180003533--business.html [12/20/12]
2 - blogs.marketwatch.com/thetell/2012/12/14/u-s-will-go-over-the-fiscal-cliff-and-markets-will-force-a-deal-nouriel-dr-doom-roubini/ [11/14/12]
3 - www.businessinsider.com/fiscal-cliff-worst-case-scenario-2012-11?op=1 [12/13/12]
4 - www.reuters.com/article/2012/10/22/us-usa-congress-fiscalcliff-idUSBRE89L0YB20121022 [10/22/12]
5 - business-news.thestreet.com/thestreet/story/3-hardest-hit-industries-if-us-goes-off-fiscal-cliff/11797229 [12/20/12]

Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022

PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO PETER MONTOYA.

MERRY CHRISTMAS 2012

Christmas is fast approaching..."the most wonderful time of year", a time to be together and make new memories.

In the hubbub associated with the season, we sometimes forget that the "little things" can represent some of the greatest gifts. When people share their love, time, experience and traditions with others, the true Christmas spirit shines. We can all give (and receive!) these kinds of presents this holiday season.

We hope this time of year is filled with such wonderful gifts for you.

Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022

PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO PETER MONTOYA.

THE SPECIAL NEEDS TRUST

A thoughtful financial move for a loved one with a disability.

If you have a child with special needs or care for an adult relative who is mentally or physically challenged, you face long-run financial demands. In all probability, federal and state assistance won't help you meet all of them.

Enter the special needs trust, an irrevocable trust designed to provide for an individual or family member's supplemental needs, assorted care and lifestyle needs that cannot be met using government assistance. A trustee uses such a trust to make various purchases of goods and services on behalf of a "permanently and totally disabled" person.1

Even wealthy families have these trusts in place - for good reason. Just to offer one example, the Autism Society estimates that 60% of autistic children will require adult services, with the average lifetime cost of care currently around $3.2 million per individual. So a special needs trust may be a wise move.2

These trusts were officially recognized by Congress in 1993; before that, they were established based on case law. They give families a smart alternative to other, potentially flawed arrangements to provide for these individuals over a lifetime.3

It is still common for a sister or brother of a newly disabled person to hold assets that once belonged to their sibling. Too often, these assets became "easy pickings" in a bankruptcy, litigation or divorce. Other families set up pooled trusts for distributing funds to their children, naming all their kids as beneficiaries; this move keeps disabled children eligible for federal and state benefits, but it also invites other siblings to fight over or lay claim to the pooled assets.2,3

Monies in a special needs trust are not exposed to creditors and are still non-countable assets so that the beneficiary can continue to qualify for social services programs and medical benefits.3

How do these trusts function? Trust assets are typically invested in securities, with the resulting income stream being used to pay for the beneficiary's needs. Conceptually, they work according to a sliding needs scale; for example, should government services somehow be able to provide for 100% of the beneficiary's needs, the trust will provide 0% and vice versa.3

The core principle is that the trust assets supplement the government benefits. This holds true if the beneficiary falls into Medicare's "doughnut hole"; it also holds true if the trust buys goods and services to improve and enhance the lifestyle of the beneficiary. The trust does not exist simply to pay for the beneficiary's basic living expenses; it may do more.3

Many of these trusts are funded with life insurance, others with assets from parents or grandparents. Still others are funded using a disabled individual's own assets, or money received from a settlement. (Intended beneficiaries of special needs trusts may not create or revoke them, even if they are mentally competent and pour their personal assets into them.)1

Sometimes parents will establish a special needs trust, yet not fund it until they pass away; a will transfers an inheritance that would go to a disabled child into the trust. The special needs trust can also be designated as a beneficiary of this or that asset, be it a life insurance policy or something else.1

Which requirements must be kept in mind? Here are some basics. The beneficiary of a special needs trust cannot have more than $2,000 in assets in his or her own name (this limit does vary by state). He or she must also be younger than 65 when the trust is established.2,3

In a self-settled trust created with funds owned by the disabled individual, leftover trust assets are wholly or partly paid back to Medicaid after the beneficiary dies to cover its costs for caring for the beneficiary during his or her lifetime. There is no such requirement for third-party special needs trusts funded by parents or grandparents. Assets within these trusts may be transferred to anyone after the death of the first beneficiary.1,2,3

The trust document's language must express a purpose to provide "supplemental and extra care" beyond what government and social services agencies offer to the trust beneficiary (not basic financial support). The trust must also be without a Crummey clause: a proviso allowing future interest gifts to be treated as present interest gifts, thereby making them eligible for the annual gift tax exclusion.3

If you wish for your loved one to have a good quality of life for years to come, a special needs trust may prove instrumental in allowing you to provide it.

Citations.
1 - clsf.info/Articles/Special_Needs_Trust.pdf [9/28/05]
2 - online.barrons.com/article/SB50001424052748704526104578117223803459976.html [12/1/12]
3 - www.nsnn.com/frequently.htm [2011]

Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022

PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO PETER MONTOYA.

TO HARVEST OR NOT TO HARVEST?

The contentious fiscal cliff negotiations in Washington have drawn a lot of attention to taxes; specifically, to the possibility that tax rates on income, capital gains and qualified dividends will go up for many of us, beginning January 1. If there is no tax deal and the automatic increases kick in, people in the 33% tax bracket will find themselves paying taxes at a 36% rate, and those paying at the 35% rate currently would jump up to the 39.6% tax bracket. Capital gains rates, meanwhile, would rise to 20%--plus the 3.8% Medicare tax on investment income for people earning more than $250,000, which actually only applies to amounts over $250,000 in that year.


Some commentators are suggesting that, faced with higher taxes, investors should turn normal tax planning on its head. Instead of harvesting losses in the portfolio to create deductions (and a lower tax bill) in tax year 2012, why not harvest gains at today's low 15% (for most of us) or 0% (for some of us) capital gains rates, and pay MORE in taxes? That way, you would reset the cost basis of the investment up to its sales price, so that the gains would be lower when the investment is sold in the future. Future higher tax rates would be applied to that lesser amount.

Interestingly, there is no wash-sale rule to worry about when you harvest gains. When you sell at a loss, the IRS requires you to wait 30 days before you can buy the same (or a similar) security. When you sell a security that has gained in value, you can buy that investment position back immediately.

For example, suppose that you own stock that is currently worth exactly $30,000, and you paid exactly $20,000 for it more than a year ago. Between now and December 31, you sell the stock and then buy it back again immediately at the same price. Capital gains taxes on that $10,000 gain come to $1,500--rather than the $2,000 you would have had to pay if you had sold the same stock at the same price in January. You saved $500, right?

If you plan to sell the stock in January, and you know for sure that capital gains taxes are going to rise once Congress finishes posturing, then this is a terrific tax-savings strategy. But what if you were planning to hold onto the stock? What if taxes on capital gains stay at their current levels?

Let's look at some of the possibilities. If the current law expires and no tax deal is reached in Washington, then capital gains rates would rise to 20%--except for investments acquired after 2001 and held for at least five years, which would qualify for a special 18% rate. If you have more than $250,000 in yearly income, you might find yourself paying at a 23.8% rate once the Medicare tax is calculated in. And there is a small chance that Congress will decide to do away with the capital gains exclusion altogether, and at the same time raise ordinary income rates back to their former 39.6%.

How long would you have to hold your investment before you'd come out ahead by NOT harvesting gains this year? It depends on the average return on your investment, and also on the future tax rate. The table below offers some scenarios. If capital gains rates go up to 20%, and you achieve an average 7% annual rate of return, then if you hold the investment for five years or more before selling and paying your taxes, your best choice would be to hold for the future. If you plan to sell before that, then taking gains now is your best option.

At the extremes, if you believe that returns will be dramatically lower than 7%, or if you believe that the 39.6% rate will apply to your future capital gains, you'll probably be better off having harvested gains today. At the other (not so extreme) side of the debate, if Congress decides to keep capital gains where they are, then harvesting gains will have increased your 2012 tax bill for no good reason. And if you hold the stock without selling for the rest of your life, then your heirs would receive it at a stepped-up cost basis--the accounting world's fancy way of saying that all the gains you earned during your lifetime would never be taxed.

Of course, this exercise doesn't take into account state taxes or AMT calculations, both of which can make the numbers vastly more complicated without greatly changing the conclusions. Nor does it take into account the trading costs involved in selling investments and then buying them back again. Over the next few weeks, we may get a bit more clarity on how investments will be taxed in 2013 and beyond. We may also see a lot of other people selling their holdings, harvesting their gains and, potentially, putting selling pressure on the investment markets--which (we are not predicting this, only suggesting it as a possibility) could cause share values to drop and make December an especially poor month to sell.

Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022

PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.